GRAT Grantor Retained Annuity Trusts

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1 GRAT Grantor Retained Annuity Trusts Blooma Stark Aronberg Goldgehn 330 N. Wabash, Suite 1700 Chicago, IL

2 What is a GRAT? An Irrevocable Trust Grantor retains an annuity amount for a period of years Section 7520 rate for month of creation must be used to value retained annuity Remainder goes to children Cannot be used for generation-skipping 2

3 Present value of remainder is a taxable gift Still possible to zero out the remainder (Walton) so no taxable gift is made Grantor must survive reserved term 3

4 GRAT & 7520 Rate If earnings and/or appreciation of assets in GRAT outperform the Sec rate, there will be assets left in the GRAT when the reserved term of years ends and remaining assets will pass on to children If earnings and/or appreciation of assets in GRAT do not outperform the Sec rate, there will be either nothing or less than the amount of the taxable gift left in the GRAT to pass to children 4

5 Death of Grantor If Grantor dies during annuity term results are uncertain Most likely that entire GRAT will be included in grantor s taxable estate Possible that only remaining annuity payments might be included in grantor s taxable estate If entire GRAT included, assets should get a step up in basis 5

6 Why Now? Ideal time to create a GRAT is when Sec rate (the hurdle rate ) is low Assets placed in the GRAT will have an increased chance of beating the hurdle rate Remainder to children will be greater Can still create a zero out GRAT 6

7 Advantages & Disadvantages Advantage of GRAT IRS sanctions use of GRAT If GRAT fails, there is no penalty for the grantor Disadvantage of GRAT assets passing to children have grantor s basis no step up in basis Proposed legislation that may require at least a 10% remainder in GRAT 7

8 7520 Rate at 2.6% $100,000 contribution to GRAT 3 year term Zero out remainder Assume earnings at 3%/ year Assume appreciation of 2%/ year Annual annuity payment is $35, Remainder to children is $5,235 8

9 7520 Rate at 2.8% $100,000 contribution to GRAT 3 year term Zero out remainder Assume earnings at 3%/ year Assume appreciation of 2%/ year Annual annuity payment is $35, Remainder to children is $4,806 9

10 7520 Rate at 3% $100,000 contribution to GRAT 3 year term Zero out remainder Assume earnings at 3%/ year Assume appreciation of 2%/ year Annual annuity payment is $35, Remainder to children is $4,378 10

11 Blooma Stark 330 N. Wabash, Suite 3000 Chicago, IL

12 Family Limited Partnerships Gary Altman Altman & Associates Rockville Pike, Suite 605 Rockville, MD

13 What is a Family Limited Partnership? Facts about a Family Limited Partnership (FLP)or Family Limited Liability Company: An entity which is established under state law The owners (or partners) are typically mom and dad and then either children or trusts for children Separate entity for income tax purposes Operates a business or owns rental real estate or owns passive assets, such as stocks and bonds 13

14 Why a FLP? Advantageous to the person seeking a mechanism that: Reduces gifts taxes; Permits retained management and income from transferred property; Avoids inclusion of gifted interests in the FLP in the transferor's gross estate at death; Reduces value of retained interests in the FLP at death of owner; Avoids probate (and possible state estate taxes) in non-resident states; and Provides some asset protection 14

15 Who Maintains Management and Control? Management and control of the FLP remains with the general partner(s). * This permits the transferor/parents to retain control of the family business, rental real estate or passive assets, even though limited partnership interests have been given to the children or other family members. 15

16 How do You Lower Gift Taxes? Limited Partner interests may be gifted to children or other family members at substantial valuation discounts, thereby lowering gift taxes. Valuation discounts are for Lack of Marketability or Minority Interest 16

17 Annual Gifting Annual gifting programs can be simplified, since limited partner interests are easier to transfer than fractional interests in the underlying assets, especially real estate. 17

18 Asset Protection FLPs insulates the FLP asset from outside creditors Limited partner interests are less attractive to creditors seeking to attach property A judgment creditor can attach the interest and become an assignee, but cannot become a partner, nor force liquidation or force distributions Alternatively, a judgment creditor can obtain a charging order -- entitles creditor to the same income distributions that the limited partner would have been entitled to. FLPs isolates the liability of the FLP assets from outside assets 18

19 What Happens in a Divorce? FLPs generally prohibit the limited partners from voluntarily encumbering their interests and include restrictions on transferability that can help keep the partnership interests in the family in the event of a divorce. 19

20 Why Not an Irrevocable Trust? Partnership agreements can be amended, but irrevocable trusts cannot. 20

21 Valuation: Determine fair market value, i.e., the price at which property would change hands between a willing buyer and a willing selling, neither under compulsion to buy or sell and both having reasonable knowledge of relevant facts. 21

22 Valuation Discounts: Minority discounts; Lack of Marketability Discounts; Discounts for transfers of undivided minority interests in real property. * What are reasonable discounts? 22

23 Considerations: Will creation have adverse consequences under any existing loan agreement? What are the transaction costs: legal, accounting, appraisals, transfer and recordation taxes? Should have a business purpose and must respect the partnership form Is a FLP workable from a practical approach? 23

24 Possible Congressional Action Disallow any discount for family limited partnerships Possible distinction between passive assets and operating businesses Definition of family members Are tenants in common interests in real estate or corporate structures less likely to be attacked by congressional action? 24

25 Gary Altman Altman & Associates Rockville Pike, Suite 605 Rockville, MD

26 Grantor Trusts Howard Sosnik Karol Hausman & Sosnik, PC 600 Old Country Road, Suite 505 Garden City, NY 11530

27 What is a Grantor Trust? Irrevocable Trust Grantor is owner for income tax purposes, but not for estate, gift, or generation-skipping transfer tax purposes. All earnings of trust are taxed to Grantor 27

28 How to Achieve Grantor Trust Status Derive benefit from income Retain power to revoke Retain power over beneficial enjoyment Exercise administrative powers *this is the only one useful for transfer tax purposes Retain a reversionary interest Examples: - reacquire trust corpus - borrow income or principal - add charitable beneficiaries 28

29 Planning Strategies Loan If assets are loaned to trust, must repay at applicable federal rate. If appreciation exceeds repayment obligation, then there is a wealth transfer. Gift Utilize lifetime gift exclusion. All appreciation out of estate. Owner pays tax on earnings. Sale Can sell assets to trust in exchange for note. Interest rate is applicable federal rate based upon term of note. No tax consequence on sale due to Grantor Trust Status. 29

30 Treatment of IDGT Income tax - disregard entity Estate tax - out of grantor s estate Gift tax - initial transfer Generation-skipping tax - allocate exemption on date of transfer 30

31 Why now? Best time to transfer assets is when values and interest rates are low. 31

32 GRAT v. Sale to IDGT Estate Tax GRAT If the transferor survives the retained interest term, the transferred property is out of the estate. If the transferor dies during the term, all or part of the property may be included. Sale to IDGT Transferred property is out of the estate immediately. If the transferor dies before the note is paid, the note is includable in the transferor s estate. It is unclear whether the underlying asset is includable in the transferor s estate if the note is outstanding at Grantor s death. 32

33 GRAT v. Sale to IDGT(continued) Gift Tax GRAT Can be structured to avoid a gift (or almost no gift) if the annuity is high enough. The GRAT can include a revaluation provision for an asset gifted to the GRAT. Sale to IDGT No gift is made if the sale is for fair market value and interest is payable at (at least) the AFR. An initial seed gift to the trust may be desirable, however. A revaluation clause is difficult, but not impossible. 33

34 GRAT v. Sale to IDGT(continued) Income Tax GRAT No sale takes place. Transferor is taxable on entire income of trust during the term. Sale to IDGT No sale is recognized as long as the trust remains a grantor trust. If the seller dies before the note is paid, the income tax consequences are not altogether certain. 34

35 GRAT v. Sale to IDGT(continued) Generation-Skipping Transfer Tax GRAT The GST exemption cannot be allocated until the end of the estate tax inclusion period (ordinarily the GRAT term). Sale to IDGT The GST exemption can be allocated immediately. This difference is a tremendous advantage that the IDGT technique has over a GRAT, which is also especially useful when transferring life insurance policies to a trust. 35

36 Howard Sosnik Karol Hausman & Sosnik, PC 600 Old Country Road, Suite 505 Garden City, NY

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